Infrastructure: Playing Defense in 2019

Timing a rotation into defensive sectors in 2019 will be critical as the longest-ever bull market draws to a close. Listed infrastructure is one such haven for investors.

Listed infrastructure has come into its own in the final quarter of 2018 as investors rotated out of growth stocks in search of more defensive assets. The trade war between the US and China is playing a key role, creating uncertainty and fuelling expectations of a slowdown.

However, we do not believe the growth cycle is over yet. The trade war will dissipate somewhat, providing the impetus for one final move upwards with investors rotating back into growth names.

But, we are very near that last hurrah for growth and the key to investing in infrastructure next year will be in timing the switch from cyclical to defensive names.

"Infrastructure stocks will become one of the key ways investors can protect themselves [from the effects of slower growth] while remaining invested."

A year of two halves

Early in 2019 we expect markets to be buoyed by the cautious actions of central banks on monetary policy in order to avoid stifling growth.

Another trigger will be a de-escalation of trade tensions. Investors should now be holding some cyclical assets – such as US rail companies – to gain exposure to above trend growth in the US.

The other asset which stands out in the infrastructure universe is the US pipeline sector. Hurt by a weaker oil price and a harsher regulatory landscape, pipeline builders, operators and owners appear to us to be attractively valued now. We expect these to be re-rated in early 2019, as Q1 is likely to see the second year in a row of earnings growth for them, something which is not reflected in prices

Europe

Across the UK and Europe political uncertainty and growth concerns mean that utilities and other infrastructure names across the continent have been oversold and look attractively valued.

We expect European growth to be firmer next year, coming in at trend rates or above, which will provide a boost to infrastructure valuations. While in the UK, a significant sell-off of the utilities sector on fears of a Labour government and a nationalisation programme have dissipated. Some of this has already been reflected in resurgent share prices of UK names, but there is more to come here and we remain overweight for now.

A push into defensive assets

We are expecting the bigger story for infrastructure to actually take place in the second half of 2019.

Having been through the headwind of rising bond yields (particularly in the US) for much of this year, yields are now near range bound and likely to remain so for much of next year, potentially peaking in 2020.

Bond yields will be more stable as growth rates slow and we expect to see just that in the US – and globally – next year, with the numbers heading back down towards longer-term trend rates. That will push investors back towards defensive assets in a similar vein to the final quarter of this year.

There are lots of reasons for this slowdown, but among them are the end of the sugar rush from the Trump tax cuts and fiscal stimulus, and all in all, it would seem to us this is a recipe for continued volatility in the year to come.

The key will be when the world acknowledges growth is slowing. When this happens, increased defensive equity exposure via infrastructure stocks will become one of the key ways investors can protect themselves while remaining invested.

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